SPC00461

DOUBLE TAXATION RELIEF – whether where the foreign income is taxed on a gross basis but forms an item of income in a Case I computation in the UK, double taxation relief is available against the whole of the UK tax on the Case I profit, or whether it is restricted to the UK tax based on a mini-Case I computation restricted to the foreign income – the former
INSURANCE COMPANY TAXATION – whether double taxation relief is calculated on the whole of the life assurance business or separately on the pension business part of the life assurance business – the latter

THE SPECIAL COMMISSIONERS

	LEGAL & GENERAL ASSURANCE SOCIETY LIMITED	Appellant

	- and -

	DAVID VIVIAN THOMAS	Respondent

		Special Commissioner: 	DR JOHN F. AVERY JONES CBE 
						DR NUALA BRICE

Sitting in public in London on 17, 20-22 December 2004

Malcolm Gammie QC and Daniel Jowell, counsel, instructed by Elaine Herbert for the Appellant

Launcelot Henderson QC and David Ewart, counsel, instructed by the Solicitor of Inland Revenue for the Respondent

© CROWN COPYRIGHT 2005

INTERIM DECISION

1.	This is an appeal by Legal & General Assurance Society Limited against estimated assessments to corporation tax for its accounting periods for the calendar years 1990 to 1998, and the Inland Revenue has raised enquiries under paragraph 24 (1) of Schedule 18 to the Finance Act 1998 for the years 1999-2001, of which 1992 and 1993 were chosen as being representative of the other years.  The Appellant was represented by Mr Malcolm Gammie QC and Mr Daniel Jowell, and the Inspector was represented by Mr Launcelot Henderson QC and Mr David Ewart.
2.	The first, and main, issue in this appeal is how the tax credit for foreign tax is calculated when the foreign country taxes income on a gross basis, for example a dividend (where foreign withholding tax is more likely to arise in practice than for interest), and the UK taxes profits of which the foreign dividend is one of the receipts.  The issue can best be described by reference to an agreed example as follows:
Foreign Case I receipt (per foreign tax system)	100.00
Foreign withholding tax	(20.00)
Post-foreign tax Case I receipt	80.00
Foreign Case I receipt (per UK tax system	80.00
Foreign tax credit that falls to be allowed	20.00
Foreign Case I receipt entering computation (s.795(2))	100.00
UK Case I receipts	4,900.00
Foreign Case I receipts	100.00
Total gross income chargeable under Case I 	5,000.00
Deductions	4,500.00
Case I profit	500.00
UK tax at 33%	(165.00)
Post-tax profit	335.00
3.	In outline, Mr Gammie, for the Appellant, contends that credit is available for the full foreign withholding tax of 20 because corporation tax of more than 20 is charged on the profit; Mr Henderson, for the Inspector, contends that the maximum credit is 3.3, the tax on 10, being the same proportion of the profit as the foreign income proportion of the total receipts (although he accepts that other methods of apportionment are possible, and we decided that the correct apportionment should be dealt with as a second stage if it arises).  The issue is of general application to the calculation of double taxation relief and has, we understand, been the subject of dispute between taxpayers and the Revenue at least since Yates v GCA International Ltd (1991) 64 TC 37.  We were shown by Mr Henderson an article by Mr David Oliver “Unilateral Relief: the Issues in Yates v GCA” [1993] BTR 201; the Chairman drew attention to the article by Mr Philip Baker QC “Some Aspects of United Kingdom Double Taxation Relief” (1998) 52 Bulletin for International Fiscal Documentation 445, which deals with the issue in this appeal; and Mr Gammie gave us an article published while we were sitting by Mr Stephen Edge “Foreign Tax Relief Credit Review for Financial Traders” The Tax Journal, 20 December 2004, commenting on the review of this issue announced in the Pre-Budget Review.  The issue is now dealt with for insurance companies in s 804C inserted by the Finance Act 2000.
4.	We had a witness statement from Mr Robert Peel, Inland Revenue, Revenue Policy (Business Tax) who also gave evidence explaining the calculation of the deduction, which we shall deal with in relation to issue No.3.  There was a statement of agreed facts as follows:  
Background information on LGAS
(1)	Legal & General Assurance Society Limited (“LGAS”) is a company registered in England and Wales.  LGAS was incorporated on 1 April 1920 under company number 166055.  Its authorised share capital is currently £1,000,000,000 divided into 1,000,000,000 ordinary shares of £1 each of which 201,430,403 have been issued and are fully paid.
(2)	LGAS has carried on business as a composite insurance company since its incorporation and is authorised in the United Kingdom to conduct both long-term and general insurance business.  For the years in issue in this appeal, LGAS was (and continues to be) engaged principally in life assurance and pensions business.
(3)	LGAS is a wholly owned subsidiary of Legal and General Insurance Holdings Ltd which, in turn, is a wholly owned subsidiary of Legal & General Group Plc (“L&G Group Plc”). L&G Group Plc is the ultimate holding company of all companies in the Legal and General group (“The Group”) and is a listed company, the activities of which encompass life assurance, general insurance, investment management and other financial services.
(4)	Accounts for LGAS are prepared to 31 December each year. Accounts for the years ended 31 December 1992 and 31 December 1993 are attached at Appendices A and B [not reproduced].  
The years under appeal
(5)	The Tax Reference for LGAS is:  277/15005.  The Tax District is:  City D Large Business Office (LBO) CT.  Tax computations and returns for LGAS have been submitted for all years to 2002. The Inland Revenue has agreed all tax computations for years prior to 1990. 
(6)	The Inland Revenue has issued estimated assessments for 1990 to 1998. Appeals have been lodged against these assessments on the basis that the assessments are estimated, may be excessive and that any profit or loss will be subject to group relief. For the years 1999-2001, the Inland Revenue has raised enquiries under Paragraph 24 (1) Schedule 18 Finance Act 1998.
(7)	The matter in issue between the parties relates to all years under appeal and for 1999 and 2000 which are the subject of Inland Revenue enquiries.  The 1992 and 1993 years have, however, been selected as representative of the issues that fall for the Commissioners’ determination.  The latest tax computations for the 1992 and 1993 years are attached at Appendices C and D [not reproduced]. 
(8)	Although in each year under appeal LGAS was carrying on a trade of insurance, in every year the Inland Revenue exercised the Crown’s option to tax LGAS’ life assurance business on what is commonly known as the “I minus E” basis.  The Inland Revenue has always so assessed LGAS.  The alternative calculation under the Crown option would be to tax all the profits of LGAS’ life assurance business in a single Schedule D Case I computation. 
(9)	The categories of life business that LGAS conducts include basic life assurance (and general annuity) business (“BLAGAB”) and pension business.  Under the I minus E basis, BLAGAB is taxed by reference to the income and realised capital gains of the business less expenses.  Pursuant to s436(1) ICTA 1988, the profits of its pension business are “treated as income within Schedule D, and … chargeable under Case VI of that Schedule” and for that purpose, “the profits therefrom shall be computed in accordance with the provisions… applicable to Case I of Schedule D”.  Section 438 (2) ICTA 1988 requires pension business receipts to be taken into account in the Schedule D Case VI computation of profits or losses notwithstanding the exemption in section 438 (1) ICTA 1988 for the income and gains of investments referable to pension business. For convenience, the total of these amounts is identified as the ‘aggregate I minus E’ amount.  
Information relating to the years 1992 and 1993
(10)	For the years ended 31 December 1992 and 31 December 1993, LGAS wrote the following long term insurance business (as categorised by Schedule 1 to the Insurance Companies Act 1982):
	Life and annuity business
	Linked long term business
	Permanent health business 
	Capital redemption business
	Pension fund management business
	Permanent health, capital redemption and pension fund management business do not constitute life assurance business.
(11)	LGAS maintained (and continues to maintain) a long term insurance fund (“LTIF”) in respect of its long term insurance business. The LTIF consists of -
	internal linked investment funds for Basic Life Assurance Business, 
	internal linked investment funds for Pensions Business, and 
	non-linked investment funds in respect of the business categories. 
(12)	The internal linked investment funds (of both Basic Life Assurance Business and of Pension Business) are internal funds of assets which back LGAS’s unit-linked life and pension policies respectively. The value of these policies is directly linked to the investment performance of the assets in the respective internal linked funds. This means that, all other things being equal, the receipt of income within the linked funds will result in a corresponding increase in the company’s liability to holders of policies backed by the assets within these funds. The benefits to be provided under these policies are determined by reference to the value of these internal funds.
(13)	The internal non-linked investment funds consist of assets which support long term business insurance policies whose benefits are not linked to the value of any internal fund. There is no direct correspondence between the receipt of any income within a non-linked fund and any increase in policyholder liabilities.  Because of the different rules of taxation which attach to the different categories of long term business, it is necessary where there are non-linked funds to identify the income etc. referable to each category.  Section 432A ICTA 1988 provides the basis for this allocation.  
(14)	 In relation to this description of the internal linked funds and the internal non-linked funds, there is no distinction between the receipt of UK income and the receipt of foreign income.
(15)	LGAS wrote both participating (with profits) and non-participating  business. Participating business consists of policies or contracts under which the policyholders or annuitants are eligible to participate in surplus.  Non-participating business consists of policies or contracts under which the policyholders or annuitants are not eligible to participate in surplus. 
The treatment of foreign income
(16)	LGAS’s linked and non-linked funds held a number of investments in foreign shares and foreign government and corporate bonds. It received investment income from these investments in the form of dividends and interest.
(17)	The bulk of the foreign income was received after the deduction of foreign withholding tax at source from the gross amount of the interest or dividend due. The foreign tax withheld was deducted at various rates, the amount of which depended on the country in which the foreign income arose. 
(18)	Appendices E to L [not reproduced] show the gross foreign investment income and the foreign tax deducted at source for the linked and non-linked funds for the years 1992 and 1993.
(19)	For accounting purposes, the foreign investment income arising from the investments held by the internal linked funds was allocated directly to the particular funds (i.e. Basic Life Assurance or Pensions Business) for which the investment was held. 
(20)	Foreign investment income arising in respect of the non-linked business was apportioned between the categories of long term insurance business on the basis of the mean of the opening and closing liabilities for each category of business for the year in question (as per section 432A ICTA 1988). 
Credit for foreign tax in 1992 and 1993
(21)	Where there is a Double Taxation Convention between the UK and the country in which the foreign investment income arose, LGAS has claimed credit relief for double taxation against UK tax under the applicable Convention. LGAS has claimed tax credit relief for foreign tax at the rate of foreign withholding tax provided by the Convention. LGAS has claimed any foreign withholding tax deducted in excess of the Convention rate directly from the relevant overseas tax authorities. 
(22)	In those cases in which there was no Double Taxation Convention in force between the UK and the country in which the foreign investment income arose, LGAS has claimed unilateral relief under section 790 ICTA 1988.  Relief has been claimed for the full amount of the foreign tax deducted from the gross amount of interest or dividends due. 
(23)	LGAS has also claimed as a deduction in respect of its pension business under section 82(1) Finance Act 1989, a proportion of the foreign tax related to that business for which credit was separately claimed against the corporation tax due on the aggregate I minus E amount. 
(24)	The following paragraphs describe more fully how LGAS has claimed credit for, and treated as an expense (part of), the foreign tax on its foreign investment income in its computations for 1992 and 1993.
(25)	For the 1992 year, LGAS’ profits chargeable to corporation tax (as shown in its most recent computations) were £12,373,200.  For the 1993 year, the corresponding figure was £128,850,321.
(26)	Special rates of corporation tax apply to the taxable profits of life insurance companies in accordance with sections 88 and 89 of the Finance Act 1989. Section 88(1) Finance Act 1989 provides that the policyholders’ share, as defined in section 89(1) Finance Act 1989, of the I minus E profits is charged to corporation tax at the rate equal to the basic rate of income tax. The remainder of the I minus E profits is taxed at the normal UK corporation tax rate for the accounting period in question.
(27)	In both 1992 and 1993, all the taxable profits in LGAS were taxed at the normal UK corporation tax rate of 33 per cent.  Accordingly, in 1992 the corporation tax chargeable before double tax relief (“DTR”) on chargeable profits after group relief was 33 per cent of £12,373,200, i.e. £4,083,156.  In 1993, the corporation tax chargeable before DTR and the set-off of Advance Corporation Tax on chargeable profits after group relief was 33 per cent of £128,850,321, i.e. £42,520,619.
(28)	Foreign withholding tax deducted at source from foreign investment income, less any tax recoverable from foreign tax authorities, and any underlying tax calculated in accordance with section 799 ICTA 1988, has been claimed as credit relief (double tax relief) in full against the total corporation tax chargeable on the aggregate I minus E amount after group relief. 
(29)	Accordingly, in 1992 the corporation tax of £4,083,156 has been fully offset by DTR to give nil net corporation tax chargeable. The foreign tax, for which DTR has been claimed in full, is analysed as follows
					      £
Linked Life funds			   110,776
Linked Pensions funds	 	   410,899
Non-linked fund			3,561,481
					4,083,156
(30)	An amount of  £2,572,053 of this foreign tax has been taken into account separately as an expense in the Case VI computation of pension business profit. (See next section and Appendices E to H [not reproduced] for further analysis). 
(31)	 In 1993, DTR of £3,875,087 has been set off against the total corporation tax of £42,520,619.  The foreign tax for which DTR has been claimed in full is analysed as follows
					       £
Linked Life funds			     29,514
Linked Pensions funds		   519,441
Non-linked fund			3,326,132
					3,875,087
(32)	 An amount of £2,615,054 of this foreign tax has been taken into account separately as an expense in the Case VI computation of pension business profit. (See next section and Appendices I to L [not reproduced] for a further analysis).
Deduction for foreign tax 
(33)	 A deduction for a proportion of the foreign tax for which credit is claimed and referable to pension business as being expended on behalf of holders of pension policies has also been made in the Pension Business Schedule D Case VI computation in accordance with section 82(1) Finance Act 1989, as applied by section 436(3)(a) ICTA 1988.
(34)	 In 1992 the Pension Business Schedule D Case VI profit in the aggregate I minus E computation is nil. Foreign tax of £2,572,053 has been deducted as an expense in arriving at the Pension Business Schedule D Case VI profit under section 82(1). The £2,572,053 represents the policyholders’ share of the sum of all the linked pensions foreign tax and the Pension Business proportion, as determined under section 432A ICTA 1988, of the non-linked foreign tax.
(35)	 In 1993, the Pension Business Schedule D Case VI profit in the aggregate I minus E computation is £19,768,612. Foreign tax of £2,615,054 has been deducted as an expense in arriving at that profit in accordance with section 82(1).  The £2,615,054 represents the policyholders’ share of the sum of all the linked pensions foreign tax and the Pension Business proportion, as determined under section 432A ICTA 1988, of the non-linked foreign tax.
Issues for determination
(36)	 For the purposes of this appeal the parties have agreed (and it is not therefore an issue for determination by the Commissioners) that the foreign tax in question is creditable tax under the relevant Double Taxation Convention or for the purposes of unilateral relief and that LGAS has made timeous claims for relief.
(37)	The issues for determination are therefore -
(a)	Whether LGAS is entitled to credit for foreign tax on the basis and in the amount claimed in its computations for 1992 and 1993 and, if not, on what basis and in what amount; and
(b)	Whether in arriving at the Pension Business Schedule D Case VI profit in 1992 and 1993 it is entitled to a deduction for foreign tax expended on behalf of holders of pension policies under section 82(1), Finance Act 1989 in respect of amounts for which it has secured credit.” 
5.	The first issue in paragraph 4(37)(a) above breaks down into what we have described as the main issue of computing double taxation relief generally (issue 1), and a second issue relating only to insurance companies, which we shall call issue 2.  The issue in paragraph 4(37)(b) above we shall call issue 3.
Issue 1
Statutory provisions
6.	The structure of Part XVIII (Double Taxation Relief) of the Taxes Act 1988 is that Chapter I is headed “The Principal Reliefs” which includes the procedure for giving effect to tax treaties in internal law (s.788), and unilateral relief (s.790).  Chapter II is headed “Rules Governing Relief by way of Credit” and sets out the detailed rules for computing credit.  As we shall see, Mr Henderson’s primary argument is that the place where the restriction on credit is found is the double taxation relief article contained in the tax treaty, which is in fairly standard form, or the unilateral relief provision in s.790 which assumes a notional treaty containing the provisions set out in subs (4) to (10), of which subs (4) is the relevant provision for our purposes.  These are:
Normal tax treaty provision
“Subject to the provisions of the law of the United Kingdom regarding the allowance as a credit against United Kingdom tax payable in a territory outside the United Kingdom (which shall not affect the general principle hereof):
(a)	Indian tax payable under the laws of India and in accordance with the provisions of this Convention, whether directly or by deduction, on profits, income or chargeable gains from sources within India …shall be allowed as a credit against any United Kingdom tax computed by reference to the same profits, income or chargeable gains by reference to which the Indian tax is computed”
Section 790(4)
“Credit for tax paid under the law of the territory outside the United Kingdom and computed by reference to income arising or any chargeable gain accruing in that territory shall be allowed against any United Kingdom income tax or corporation tax computed by reference to that income or gains….”
7.	These are extremely similar and require credit for foreign tax against any United Kingdom tax computed by reference to the same profits, income or chargeable gains (treaty relief), or by reference to income arising or any chargeable gain accruing in the territory (unilateral relief).  The words “computed by reference to” were previously “in respect of,” before being changed in the Finance Act 1967 and by the renegotiation of most treaties (the 1952 Jersey treaty which is one of those relevant to this appeal is a surviving example of the old wording).  The words “in respect of” had given rise to difficulties with the interaction with the preceding year basis in New Zealand in Duckering v Gollan (1965) 42 TC 333.  As the headnote records, “the UK tax for the year 1958-59 was based on the income arising in 1957-58.  New Zealand tax for 1958-59 was based on the current year’s income but for 1957-58 had been based on the preceding year’s income, so that no assessment was based on the income of 1957-58.  The [taxpayer] claimed that the New Zealand tax for 1958-59 should be allowed as a credit against the UK tax for that year, but the Inspector of Taxes objected to the claim.”  In brief, the case decided that the taxpayer was entitled to credit for the amount paid in 1958-59, thereby matching the New Zealand income earned in 1958-59 with the UK income earned in 1957-58.  The Finance Act 1967 restored the Revenue’s view that the credit should be based on the same income, which would have had the result in that case that no credit would have been obtained because the income earned in 1957-58 in New Zealand was never used as a basis for assessing New Zealand tax.  As Hoffmann J said in George Wimpey International Ltd v Rolfe 62 TC 597, at p.606F the amendment “was intended to ensure that the identity was not between funds which might notionally be regarded as the taxable income in the foreign territory and the UK but between the actual funds by reference to which the computation of tax was made.”  
8.	By s.788(3) the tax treaty shall “notwithstanding anything in any enactment have effect in relation to income tax and corporation tax in so far as they provide—(a) for relief from income tax, or from corporation tax in respect of income or chargeable gains…”.  It is therefore possible for the treaty itself to contain the limit or for the limit to be found in the internal law provisions referred to in the opening words of the treaty provision.  Indeed the relief article in the treaty is where the limit is to be found in the OECD Model, the credit provision of which is quite different from the normal UK provision and makes no reference to internal law rules: 
“Such deduction [i.e. credit]…shall not, however, exceed that part of the income tax,…as computed before the deduction is given, which is attributable,…to the income which may be taxed in that other State” [references to capital taxes omitted].
The Commentary to article 23B (the credit provision) in the Model shows that the issue in this appeal is addressed in the Model:
“63. The maximum deduction is normally computed as the tax on net income, i.e. on the income from State…S [the source state] less allowable deductions (specified or proportional) connected with such income….  For such reason, the maximum deduction in many cases may be lower than the tax effectively paid in State…S.  This may especially be true in the case where, for instance, a resident of State R [the taxpayer’s residence state] deriving interest from State S has borrowed funds from a third person to finance the interest-producing loan.  As the interest due on such borrowed money may be offset against the interest derived from State S, the amount of net income subject to tax in State R may be very small or there may even be no net income at all…”.
9.	Section 788(4) suggests that Chapter I is defining when credit is given in principle while the details are contained in Chapter II:
“The provisions of Chapter II of this Part shall apply where arrangements which have effect by virtue of this section provide that tax payable under the laws of the territory concerned shall be allowed as a credit against tax payable in the United Kingdom.”
10.	As we shall see, Mr Henderson’s alternative argument is that the restriction is found in s.797 in Chapter II.  In 1993-94 this provided:
797. Limits on credit: corporation tax 
(1) The amount of the credit for foreign tax which under any arrangements is to be allowed against corporation tax in respect of any income or chargeable gain (“the relevant income or gain”) shall not exceed the corporation tax attributable to the relevant income or gain, determined in accordance with subsections (2) and (3) below.
(2) Subject to subsection (3) below, the amount of corporation tax attributable to the relevant income or gain shall be treated as equal to such proportion of the amount of that income or gain as corresponds to the rate of corporation tax payable by the company (before any credit under this Part) on its income or chargeable gains for the accounting period in which the income arises or the gain accrues (“the relevant accounting period”).
(3) Where in the relevant accounting period there is any deduction to be made for charges on income, expenses of management or other amounts which can be deducted from or set against or treated as reducing profits of more than one description—
(a) the company may for the purposes of this section allocate the deduction in such amounts and to such of its profits for that period as it thinks fit; and 
(b) the amount of the relevant income or gain shall be treated for the purposes of subsection (2) above as reduced or, as the case may be, extinguished by so much (if any) of the deduction as is allocated to it….” 
Before 1972, that provision, as s.505 of the Taxes Act 1970, dealt only with income and read:
The amount of the credit for foreign tax which under any arrangements is to be allowed against corporation tax in respect of any income shall not exceed the corporation tax attributable to that income.”
Mr Gammie pointed out that this was the profits tax wording (see para. 4 Sch 16 Income Tax Act 1952 which was taken over for corporation tax, see section 64 of the Finance Act 1965), because the equivalent income tax provision dealt with tax at different rates.  In Collard v Mining and Industrial Holdings Ltd 62 TC 448, 489E Lord Oliver described the effect as follows:
“To summarise shortly the philosophy behind these provisions, so far as it can be gathered from the words used, that behind the double taxation provisions of the Act of 1970 is that, where a double taxation convention exists and applies, foreign tax suffered on dividends paid to a United Kingdom resident company is to be added back for the purpose of ascertaining that company's gross income for the purpose of U.K. corporation tax. The corporation tax is then ascertained on the grossed-up income so produced and the foreign tax is then credited up to a ceiling of the amount of that corporation tax for the purpose of ascertaining the company's liability to corporation tax. Thus the foreign tax credit may result in there being no liability for corporation tax at all on the relevant income (where, for instance, the foreign tax suffered is at a rate equal to or greater than the rate of corporation tax) but it can never exceed the amount of corporation tax which would be payable had there been no such credit. There can therefore be no question of any repayment to the taxpayer of foreign tax suffered.”
In 1972, the separate provision (s 499 of the Taxes Act 1970) dealing with gains that had incorporated the provisions dealing with income by reference was repealed and s 505 was made applicable to gains as well.  Section 100(3) of the Finance Act 1972 provided:
“For the purpose of section 505 of the Taxes Act [1970] (which limits the credit for foreign tax allowable against corporation tax in respect of any income to the corporation tax attributable to that income and, by virtue of subsection (1) above, applies similarly in relation to chargeable gains) the corporation tax attributable to any income or gain (“the relevant income or gain”) shall be determined in accordance with subsections (4) to (6) below” [of which subs (4) and (5) correspond to s.797(2) and (3) quoted above].
Thus in 1972 the limit changed from the undefined “attributable to” the foreign income, to the tax so attributable determined as the average rate of corporation tax payable by the company (subs (2)), after having attributed charges, expenses of management and other deductions from profits of more than one description as the taxpayer allocates (subs (3)).  We discuss below the reason for this change which may be connected with the differential rate of corporation tax on income and gains introduced by the Finance Act 1972.  Mr Gammie pointed out that what is now subs (3) may have been introduced on account of doubts expressed by Lord Wilberforce in the House of Lords the year before in Jones v Shell Petroleum (1971) 47 TC 194 that allocation of management expenses to the advantage of the taxpayer was one possible method which was convenient but he expressed no opinion as to its authenticity (p.214F).  Parliament may have wanted to put the existing practice beyond doubt.  Commercial Union Assurance Company v Shaw (1998) 72 TC 101 decided that this right to allocate is for the purposes of determining the corporation tax attributable to the relevant income for double taxation relief purposes; it cannot permit a company to allocate a deduction greater than the profits.
11.	Other relevant provisions contained in Chapter II are as follows:
“793. Reduction of United Kingdom taxes by amount of credit due 
(1) Subject to the provisions of this Chapter, where under any arrangements credit is to be allowed against any of the United Kingdom taxes chargeable in respect of any income or chargeable gain, the amount of the United Kingdom taxes so chargeable shall be reduced by the amount of the credit.
795. Computation of income subject to foreign tax
(2) Where credit for foreign tax falls under any arrangements to be allowed in respect of any income or gain and subsection (1) above does not apply [subs.(1) applies to income tax], then, in computing the amount of the income or gain for the purposes of income tax or corporation tax—
(a) no deduction shall be made for foreign tax, whether in respect of the same or any other income or gain…”.
Section 798, which is not set out, but contains limits on credit for tax on foreign loan interest included in profits and is therefore dealing specifically with the issue in this appeal in relation to foreign interest.
811. Deduction for foreign tax where no credit allowable 
 (1) For the purposes of the Tax Acts, the amount of any income arising in any place outside the United Kingdom shall, subject to subsection (2) below, be treated as reduced by any sum which has been paid in respect of tax on that income in the place where the income has arisen (that is to say, tax payable under the law of a territory outside the United Kingdom).
 (2) Subsection (1) above—
(a) shall not apply to income the tax on which is to be computed by reference to the amount of income received in the United Kingdom;…
and this section has effect subject to section 795(2).”
Sections 795 and 811 interact so that if credit “falls to be allowed” one takes the income gross of the foreign tax, but if not, one is given a deduction for the foreign tax.
Contentions of the parties 
12.	 Mr Gammie, for the Appellant, contends that: 
(1)	The treaty provision first establishes the tax for which credit is to be given: “Indian tax payable under the laws of India and in accordance with the provisions of this Convention, whether directly or by deduction, on profits, income or chargeable gains from sources within India.”  Next it identifies the foreign income with the same income that has entered into the computation of income for UK tax: “any United Kingdom tax computed by reference to the same profits, income or chargeable gains by reference to which the Indian tax is computed.”  Unilateral relief is to the same effect.  Chapter I of Part XVIII establishes the foreign tax for which you can claim credit, and Chapter II tells you what you can credit it against.  If the draftsman had intended Mr Henderson’s interpretation of “any UK tax computed by reference to the same profits” to mean the amount of UK tax properly attributable to that foreign income he would not have said any UK tax but something like “that amount of UK corporation tax that arises as a result only of the same foreign profits.”  
(2)	The same fund that Wimpey requires to be identified existed between the grossed-up foreign income and the same gross item entering into the UK computation.  Yates v GCA International Ltd (1991) 64 TC 37 was a question of different computation of business profits in each country and the parties should have agreed that the whole of the Venezuelan tax was creditable up to the limit in s 797(2).
(3)	The words “computed by reference to” and the earlier “in respect of” were used for the purpose of identifying the income in each country rather than introducing any limit.  Mr Henderson’s interpretation requires a “mini-Case I computation” starting with the foreign income which is never required to be made.  The only limit is found in s 797 which specifies the limit as the average UK rate of tax.  
(4)	He points to the absence of any method of apportionment set out in the statute.
(5)	Section 797 is superfluous on the Revenue’s interpretation.  Even if expenses or deductions were zero their limitation would achieve the same result.
(6)	Where under s 795 “credit for foreign tax falls under any arrangements to be allowed” one grosses-up the income by the full 20 of foreign tax, whereas if the only credit were 3.3 one should gross it up only to 83.3.
(7)	Finally, he reserves the right to argue that, if we agreed with Mr Henderson’s interpretation, this was a restriction on investment abroad contrary to European law.
13.	Mr Henderson, for the Inspector, contends that:
(1)	Mr Gammie’s interpretation is anomalous because the higher the expenses allowable in the Case I computation the greater the credit against the tax attributable to income other than the foreign income, which shows that it cannot have been intended.
(2)	The purpose of the treaty or unilateral relief provision is to avoid double taxation on the same fund of income, see Wimpey.  This involves narrowing down the total corporation tax to tax on the particular Schedule or Case, here Case I.  Hoffmann J endorsed the Special Commissioner’s reference to “the necessity…of exactly identifying the fund charged to overseas tax with a fund chargeable also to UK tax.”  
(3)	The fund chargeable to corporation tax which is exactly identifiable with the foreign income is not the whole of the company’s Case I profits, but rather so much of the Case I profits as is referable or attributable, on Case I principles to the foreign income.  In other words, it is necessary to carry out what might be called a mini-Case I computation in order to identify the UK profit which corresponds exactly with the foreign taxable income.  It is the corporation tax on that UK profit, not the corporation tax on the Case I profit as a whole, which as a matter of construction of the treaty is the UK tax “computed by reference to the same…income” as the foreign taxable income.
(4)	It is not an objection that the limitation is not made more explicit or that no machinery is provided for ascertainment of the UK tax as one would not expect a treaty to enter into detail of that nature.  The OECD Model merely lays down the principle in general terms.  
(5)	The unilateral relief provision in s 790(4) is worded in similar terms and must be construed in the same way.  In determining the figures in Yates v GCA International Ltd (1991) 64 TC 37, 39 the Special Commissioner decided the issue in accordance with the interpretation for which he contends.
(6)	The alternative provision containing a limit on credit is s 797.  The relevant income or gains” defined in subs (1) must be the UK fund of taxable income, as demonstrated by subs (3) which refers to reducing or extinguishing that amount by deductions allocated to it.  Any limitation found in the treaty or unilateral relief is carried over into s 797 which adds a further limitation of the average rate as calculated by subs (2) thus ensuring that credit is not obtainable for foreign tax at a higher rate, and that credit cannot create a tax loss. 
Reasons for our decision
14.	In the example in paragraph 2 if one starts, as Mr Henderson does, with the allocation of expenses to give a mini-Case I computation of the profit referable to the foreign income there are obvious merits in his interpretation, that the UK should not be assumed to have negotiated a treaty or drafted unilateral relief on the basis that the UK could tax 10 of profit but had to credit foreign tax of 20, all but 3.3 of which is against tax on other income.  But if, as Mr Gammie does, one ignores the allocation of the expenses and the mini-Case I computation, there are merits in his interpretation, the principal one being that it is consistent with capital export neutrality, on which the tax credit system is based (at least so long as the rate of foreign tax is lower than the UK rate), so that the tax is the same whether the 100 arose in the UK or abroad.  Each of them was able to point to absurdities in the other’s interpretation.  Mr Gammie explained the fundamental difference between him and Mr Henderson to be not so much whether one took the foreign or UK measure of income, because Mr Gammie contended that the UK measure of income was the treaty measure (which was incorporated into UK law by s 788) of the grossed-up foreign income, but where the computation starts.  Mr Gammie starts with the grossed-up dividend, which is what the treaty article deals with; Mr Henderson starts with the Case I profit and from that (including for that purpose taking into account the grossed-up dividend) makes a mini-Case I computation to derive what he contends is, in the treaty wording, the UK tax on the part of the profit “computed by reference to the same income by reference to which the [foreign] tax is computed,” or in unilateral relief “computed by reference to income arising or any chargeable gain accruing” in the territory.  Essentially therefore the issue is whether the legislation directs one to make such a mini-Case I computation.
15.	We first consider the guidance from the authorities on this question.  George Wimpey v Rolfe (1987) 62 TC 597 concerned a company carrying on a worldwide trade on which it made an overall loss, but it had been taxed on profits in three foreign branches in non-treaty countries.  It sought to set the foreign tax against the total corporation tax it paid in the year, mainly tax on interest.  The Revenue’s argument before the Special Commissioner for not setting the foreign tax against tax on other income was:
“…founded on the proposition that the statutory references to “income” were to income in the sense understood by the Taxes Acts. Trading “income” is, according to the applicable rules, a sum of profits after deducting allowable charges and other expenditure. Where, as here, there is a single worldwide trade, the trading income is the overall result in which the results of individual trading ventures are subsumed. The company's trading in 1984 produced nil profits. It followed that if, notwithstanding that, there were “total profits” on which corporation tax was chargeable, such tax must be referable to the existence of other sources of income. It could not be said to be “computed by reference” to any trading income (let alone to the particular overseas amounts in question); nor was any corporation tax “chargeable in respect of” any trading income. No unilateral relief in respect of the overseas (trading) taxes thus being available, s 505 [now s.797] was not actually material: but in terms of that section, if the corporation tax attributable to the relevant income is nil, that was the limit.” 
16.	This argument was accepted by the Special Commissioner:
“In my judgment not all the references to “income” are directed specifically to income or profits as computed for income tax purposes. That in s 498(1) [now s 790 and since the Finance Act 1972 applying also to capital gains] seems to be simply to “income”, as distinguished from “capital”. And (as I think Mr. Waterson [for the Revenue] realises) there may be some difficulty in applying s 516 [now s 811] in circumstances such as are present here if too narrow a view of “income”, is adopted. Yet the Crown says that section does apply. I do not think I need say any more about that section, save for just one observation. It envisages a situation in which an overseas taxed fund (to use a neutral word) is brought into the UK computations, notwithstanding which, double taxation relief is not available. The general thrust of Mr. Oliver’s argument [for the taxpayer] does not seem to me to lie very comfortably alongside such a situation. 
In considering the matter I have been struck by the curious phrase in s 501(1) [now s 793(1)] “… any of the United Kingdom taxes chargeable in respect of any income …” It would be an odd way of saying “income tax or corporation tax”.  In my opinion, the section is treating income tax under the different Schedules, and Cases within Schedules, as separate taxes. That accords with the necessity, evident throughout, of exactly identifying the fund charged to overseas tax with a fund chargeable also to UK tax. The 1967 amendment to what is now s 498(3) [now s 790(4)], substituting “computed by reference to” for “chargeable in respect of”, following the decision in Duckering v Gollan 42 TC 333, has just that objective. 
….In my opinion therefore if the company is to succeed on its full claim it must be able to point to a trading fund chargeable to UK tax. That it cannot do, by reason of the facts (i) that, there being a single trade, the foreign trading funds are subsumed within the overall trading result, and (ii) that that result was a loss.” 
17.	Mr Gammie suggested that the reason for the apparently odd wording mentioned in the second paragraph quoted was because the provision originally applied to both income tax and profits tax.  On appeal, Hoffmann J upheld the Special Commissioner’s decision saying:
A basic principle of United Kingdom income tax law is that tax is charged by reference to various kinds of income identified according to their source under the Schedules and Cases of the Act. Each Case has its charging provisions which identify the income to be taxed together with ancillary provisions in accordance with which that income is to be computed.  When s 501 [now s 793] speaks of United Kingdom tax chargeable “in respect of any income” it therefore means, in relation to income tax, the tax chargeable by virtue of one or other of the Cases in the Schedules. Each Case gives rise to a separate computation of income and consequently of tax. If, therefore, the Appellant had been an individual liable to income tax I do not think it would have been said that any United Kingdom tax in respect of which he was chargeable had been computed by reference to income which arose in the foreign territory.  The only computation into which that income would have entered would have been for the purposes of Case I of Sch D, and which produced no liability to tax.  Nor could any tax be said to have been charged “in respect of” that income. 
Does it make any difference that the Appellant is a company chargeable to corporation tax on its total profits calculated in accordance with, among other things, s 177(2) and s 250(3)? I do not think that it does. Income for the purposes of corporation tax is computed according to income tax principles under the same Schedules and Cases. It would therefore be very odd if a company was entitled to double taxation relief denied to an individual. In my view double taxation relief is intended to ensure that the taxpayer does not suffer tax twice charged upon the same income. In Ostime v Australian Mutual Provident Society [1960] AC 459 at page 480, Lord Radcliffe, speaking in general terms of bilateral double taxation treaties, said: “The aim is to provide by treaty for the tax claims of two governments both legitimately interested in taxing a particular source of income”. This, of course, is a case of unilateral relief, but as it operates, as I have said, by deeming a treaty to exist, the underlying purpose must in my view be the same. This is why s 501 [now s 793] assumes that the effect of double taxation relief, whether bilateral or unilateral, will be to allow a credit against a United Kingdom tax chargeable in respect of identifiable income.  It assumes one will have identified the income in respect of which United Kingdom tax is being imposed, and that this income will be the same as the income arising in the foreign territory in respect of which the credit is to be allowed.  As the Special Commissioner said, there is evidence throughout the scheme of this legislation of “the necessity … of exactly identifying the fund charged to overseas tax with a fund chargeable also to UK tax”.
   The reference in s 498(3) [now s.790(4)] to United Kingdom tax being “computed by reference to” the income on which the foreign tax has been computed was introduced by the Finance Act 1967 in consequence of the decision in Duckering v Gollan, 42 TC 333, and was intended to ensure that the identity was not between funds which might notionally be regarded as the taxable income in the foreign territory and the United Kingdom but between the actual funds by reference to which the computation of tax was made. This identification of the income subject to United Kingdom corporation tax can in my judgment only be made in accordance with income tax principles. On this basis it seems to me that the income in respect of which the company became liable to corporation tax was its non-trading income notwithstanding that the computation of that income was made subject to deduction for losses which took into account the company's trading in the three territories. The company was not chargeable to any tax in respect of the income which had been subject to foreign tax.  No credit can therefore be allowed, and the appeal must be dismissed. 
18.	The principle in Wimpey is therefore “the necessity…of exactly identifying the fund charged to overseas tax with a fund chargeable also to UK tax.”  This is done on a schedular basis, and on the facts of that case, unlike a life assurance company, the investment income was not a receipt used in computing the trading profit.  In that case, the identification was easy: the foreign branch profits were not charged to UK tax as the Case I result for the year was a loss.  The issue in this appeal is essentially whether, if there had been a profit, one credits the foreign tax against any tax paid on income taxed under the appropriate schedule, here Case I, or whether one goes further and does a mini-Case I computation in order to ascertain the part of the profit referable to the foreign income.  Since the foreign branches made profits, at least when computed by their own territories, and the Case I loss was a loss of he worldwide trade, it was necessary to look at the results of the worldwide trade and not a part of it because there was no UK tax payable on the results of the worldwide trade.  The issue in this case is whether the same approach would apply if there had been a profit.
19.	This issue was dealt with only by the Special Commissioner in Yates v GCA International Ltd (1991) 64 TC 37.  UK resident consultants in the oil industry entered into a contract relating to oil fields in Venezuela, part of the work for which was to be done in Venezuela and part in the UK.  The fee was $209,300 (£97,345) of which $48,300 (£22,464) was attributed by the contract to work in Venezuela.  Venezuela taxed 90% of the total income and withheld the equivalent of £22,353 in respect of the whole fee.  The main issues were whether the Venezuelan tax qualified for credit and how much income was sourced there, but the issue of the amount of credit was also in issue.  On this aspect the taxpayer contended (p.42D):
“6.  Section 505 of the Taxes Act [1970] falls to be construed in accordance with ss.100(4) and (5) Finance Act 1972 [now s.797(2), (3)].
7. Under s.100(4) Finance Act 1972 [now s.797(3)] the company is entitled to allocate any deductions from income to other profits.
8.  Accordingly the company is entitled to the full amount of the relief claimed.” 
The Revenue contended (p.43B):
“3. By the combined effect of s 505 of the Taxes Act and s 100 Finance Act 1972 [now combined in s.797], the amount of any tax credit relief for which a taxpayer company is eligible under s 498(3) of the Taxes Act [now s.790(4)] is so restricted as not to be permitted to exceed the figure produced by applying the rate of corporation tax payable by the taxpayer company in its relevant accounting period to the amount as measured for UK corporation tax purposes of the income upon which the foreign tax eligible for credit relief is levied. 
4.   In the alternative, under s 498(3) of the Taxes Act [now s.790(4)], credit for foreign tax to which the company is entitled is allowable only against UK corporation tax computed by reference to the same income by reference to which the foreign tax eligible for credit relief is computed.” 
20.	The Special Commissioner’s decision on this (p.47C) was:
“[The Revenue’s] third and fourth submissions…are in the alternative but produce the same result arithmetically. That is not surprising as they are almost the same figures, one of which is the company's trading profit of £40,995.00. That figure may, for all I know, be capable of amendment pursuant to s 100(5) Finance Act 1972, thus producing an entirely different final result to the calculations in question. I will however, consider what the broad effect of s 498(3) of the Taxes Act [now s.790(4)] must be.
 In an authority not cited to me namely Brooke, Bond & Co. Ltd. v Butter 40 TC 342 Wilberforce J. (as he then was) said at p. 353 in relation to the predecessor of s 498(3) [now s.790(4)]:
 	‘So that states the simple and intelligible principle that any tax paid under the law of a foreign territory in respect of income arising in that territory is to be allowed.’
  The learned judge was however considering the words of a slightly different provision, for the present form of s 498(3) [now s.790(4)] emerged only in s 36 Finance Act 1967, when the words ‘computed by reference to’ replaced words in para 1 Part I of Sch 17 Income Tax Act 1952 in two separate places. Those changes must be given effect to if possible and therefore I can see no alternative to accepting the principle behind [the Revenue’s] fourth contention.
….
Although [the Revenue] had prepared precise figures to put to me in relation to his contentions, [counsel for the taxpayer] was unable to do so. Nevertheless I have been assured by the parties that if I give decision in principle only, it should be possible for them to agree figures. I therefore adjourn the matter generally in the hope that they will be able to do so, to enable me to formally determine the appeal.”
21.	The case stated (p.39) records:
“6. The parties were unable to agree figures following my Decision in principle. At an adjourned hearing on 31 January 1989 I determined the amount of the company’s claim in the sum of £571.”
22.	Although the case stated does not record the arguments or the reason for his decision, the figure of £571 can easily be derived from the other figures in the report as the proportion of the UK profit (£40,995) (p 47D) corresponding to the proportion of the turnover for work in Venezuela (£22,464) to the total turnover (£839,498) (p 41C, although it is there described as the group turnover), which is 2.67% equals £1,097 on which tax at 52 per cent is £570.43.  This is presumably the figure for which the Revenue were contending.  The Special Commissioner therefore decided that the limit on credit was an apportioned part of the Case I income as being the same income for the purpose of what is now section 790(4).  There was no appeal against that part of the decision.  We agree with Mr Henderson that because the decision was made after an adjourned hearing this is a decision of the Special Commissioner on the precise point in issue in this appeal, although it is fair to say that it was not the main issue in that appeal.  Unfortunately no reasons are given for the Special Commissioner’s decision at the adjourned hearing and he clearly did not have the benefit of the four days’ argument on the point that we had.
23.	Before turning to the statutory provisions our preliminary view is that it seems to us that Mr Henderson’s interpretation gives a common sense result and is supported by the Special Commissioner’s decision in GCA.
24.	In considering the statutory provisions we start by noting that they are expressed in general terms, presumably because they have to deal with a wide variety of situations, including (a) where both countries tax the gross income (an individual receiving a foreign dividend, although it should be noted that there is a differently-calculated limit for credit for income tax from that in corporation tax based on the individual’s marginal rate of tax in s 796); (b) where the UK allows expenses of management as the taxpayer allocates (an investment company receiving a foreign dividend); (c) where both countries tax a profit (the branch profit case in which the foreign branch profit is a part of a larger profit taxed in the UK—we leave aside the problem that each country is likely to have a different calculation of the profit); and (d), as here, where the foreign country taxes the gross dividend at (normally) a reduced rate of withholding tax permitted by the treaty, and the UK taxes a profit of which the foreign income is one of the items of income leading to the calculation of the profit.  
25.	The treaty and unilateral reliefs both require identification of the foreign income with the UK income against the tax on which the credit is to be allowed.  This is any United Kingdom tax computed by reference to (formerly “in respect of”) the same profits, income or chargeable gains (treaty relief), or “any United Kingdom income tax or corporation tax computed by reference to (formerly “in respect of”) income arising or any chargeable gain accruing in that territory” (unilateral relief).  In cases (a) and (b) in paragraph 24 above this process may result in the identification by both countries of the same gross income which is taxed in both countries.  In case (c) the treaty requires the identification of a foreign branch profit with that part of the total profit as a result of the treaty wording (not present in the Indian treaty) that “…there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise…”.  The only reason for the UK, as residence state, which taxes the worldwide income being concerned with the computation of the branch profits is for the computation of credit.  In case (d), which is the situation in this appeal, the issue is whether “United Kingdom tax computed by reference to the same profits, income or chargeable gains” (or the equivalent unilateral relief wording) is the Case I profit computed by including the foreign dividend plus any other income falling within the computation of the profit, or whether it is a profit computed by including solely the foreign income and setting against it a proportion of the deductible expenses.  We regard the words “computed by reference to” as important and we consider that these refer to an actual computation made on a schedular basis (as decided in Wimpey) rather than one made specifically for the purpose of calculating the relief.  If the draftsman had intended that a computation had to be made specially for the purpose of calculating the relief it would not be natural to refer to “UK tax computed” but one would expect to be told to make such a computation, possibly stating the basis on which this was to be done (although we accept Mr Henderson’s argument that in the context of laying down general rules this might be left open).  The OECD Model uses words in this context making it clear that one looks to tax attributable solely to the foreign income: “…that part of the income tax…as computed before the deduction is given, which is attributable… to the income…which may be taxed in that other State.”  We cannot read into the UK treaty or unilateral relief wording that they are quantifying or restricting the relief by requiring a profit computed by reference to the foreign income only.  We therefore respectfully differ from the Special Commissioner’s decision in Yates v GCA International Ltd.  
26.	If the treaty provision merely identifies the UK tax against which credit is given in principle but refers to internal law, i.e. Chapter II headed Rules Governing Relief by way of Credit, for the details of the amount of the credit, the question is whether a limit based on a mini-Case I computation is contained in s 797.  We repeat the opening words of s 797:
“(1) The amount of the credit for foreign tax which under any arrangements is to be allowed against corporation tax in respect of any income or chargeable gain (“the relevant income or gain”) shall not exceed the corporation tax attributable to the relevant income or gain, determined in accordance with subsections (2) and (3) below.”
27.	Although in Collard v Mining and Industrial Holdings Ltd 62 TC 448, 490C Lord Oliver noted that “The philosophy behind s.100 is more difficult to detect,” it seems to us (although we should say that the point was not argued) that the reason it was necessary to unify the provisions relating to income and gains and to define how the tax attributable to the income or gains was to be calculated was because s 93 of the Finance Act 1972 introduced different rates of corporation tax on income and gains, applying immediately to unit and investment trusts but with the extension from 1 April 1973 to all other companies provided for by s 93.  From that date the effect for other companies was that while corporation tax was increased from 40% to 52% on income, it was reduced to 30% on gains (by the mechanism of reducing the gain by the fraction 11/26 (Finance Act 1974 s 10)).  Another reason may have been the introduction of the small companies rate of corporation tax (s 95) so that in another respect corporation tax ceased to be charged at a flat rate as it had been previously, and as profits tax had been.  
28.	Mr Gammie and Mr Henderson disagreed about the interpretation of the reference in s 797 to “any income” in the expression “The amount of the credit for foreign tax which under any arrangements is to be allowed against corporation tax in respect of any income or chargeable gain (‘the relevant income or gain’)…”.  Mr Gammie contended that it meant the income identified by the treaty and s 795, which was in this case the gross dividend, but might be a figure net of expenses in the case of branch profits.  Mr Henderson pointed to the use of the defined expression “the relevant income or gain” in s 797(3) where that amount is reduced by the deduction of expenses of management etc allocated to it, where it must mean the UK taxable measure of the profit, which on his argument must mean the mini-Case I profit.  The same point could be made in relation to subs (2) which provides that: 
“…the amount of corporation tax attributable to the relevant income or gain shall be treated as equal to such proportion of the amount of that income or gain as corresponds to the rate of corporation tax payable by the company…”.
If one is applying a rate of tax it is natural to apply it to the income or gain that is being taxed.  The same expression “in respect of any income or chargeable gain” is also used in s 793(1):
“…where under any arrangements credit is to be allowed against any of the United Kingdom taxes chargeable in respect of any income of chargeable gain, the amount of the United Kingdom taxes so chargeable shall be reduced by the amount of the credit.”
And in s 795(2):
“Where credit for foreign tax falls under any arrangements to be allowed in respect of any income or gain…then, in computing the amount of the income or gain for the purposes of income tax or corporation tax—(a) no deduction shall be made for foreign tax…”.
In all four places the provision seems to refer to the taxable measure of UK income: in s 793 it is immediately followed by a reference to the UK taxes so chargeable being reduced by the credit, and so the tax is on that income; in s 797 the limit on the amount of the credit is being defined; and in s 795 it is part of computing the amount of income for tax purposes.  All these point to an actual computation of income that is being made for tax purposes.  As Hoffmann J said in the passage quoted in paragraph 17 above: “When s 501 [now s 793] speaks of United Kingdom tax chargeable “in respect of any income” it therefore means, in relation to income tax, the tax chargeable by virtue of one or other of the Cases in the Schedules.  Each Case gives rise to a separate computation of income and consequently of tax.”  In the following paragraph he concludes that the result is the same for corporation tax.
29.	Section 797 starts by referring to the foreign tax “which under any arrangements is to be allowed against corporation tax in respect of any income or chargeable gain (‘the relevant income or gain’).”  This is a reference to the income or gain previously identified by the treaty provision as “the same profits, income or chargeable gains,” or by the unilateral relief provision in s 790(4) as “that income or gain,” which in relation to income in accordance with Wimpey means income computed under the Cases and Schedules.  Next, by s 797(3) this item of income or gain is reduced by any charges on income, expenses of management or other amounts deductible against profits of more than one description (charges for short) set against it, because the item is not taxed to the extent to which charges are set against it.  As was decided in Commercial Union Assurance Co plc v Shaw 72 TC 101, that allocation of charges is for “the limited purpose of the section, that is to say the purpose of determining the corporation tax attributable to the relevant income or gain” (p 129A), and so cannot exceed the item of income so as to produce a loss.  Finally, s 797 sets the limit for credit as the rate of corporation tax (which could then be different for income or gains) on the item income or gain as reduced by charges.  We therefore prefer Mr Henderson’s interpretation that the “relevant income or gain” is the UK taxable measure of the income or gains, rather than Mr Gammie’s that it is the income as defined by the treaty grossed-up for the foreign tax.  But this interpretation does not lead to the conclusion for which Mr Henderson contends because it is reference to an actual computation of income under the Cases and Schedules and not a mini-Case I computation made for the purpose, particularly as charges are not allocated to mini-Case I profits but to actual profits.  Since the relevant income or chargeable gain is in this case the actual Case I profit, all s 797 is saying is that the credit shall not exceed the average rate of corporation tax on that profit.  In the example, the Case I profit is £500 and the credit of £20 does not exceed the UK tax of £165.  
30.	We are fortified in this conclusion by the fact that s 798 has been enacted on the basis that the Appellant’s interpretation is correct, although we agree with Mr Henderson that the section can be explained by setting out how to carry out the apportionment.
31.	Our conclusion is that while Mr Henderson’s interpretation seems to us to be the one that it might be expected that Parliament and the treaty negotiators would have wished to achieve, we cannot find sufficient support for it either in the words “computed by reference to (formerly “in respect of”) the same profits, income or chargeable gains” in the treaty provision (or similar wording in the unilateral relief provision) or in the words “computed by reference to income arising or any chargeable gain accruing in that territory” in s 797.  We conclude that in the example in paragraph 2 the full credit of 20 is allowed against the tax of 165 charged on the whole of the Case I profits.
Issue 2
32.	The second issue is the relevance of the first issue to insurance companies.  It is whether double taxation relief is computed on the life assurance profits as a whole or separately on the pension business profits forming part of the life assurance business.  As with issue 1, this issue is best illustrated by an example introduced by Mr Gammie.  A company carries on (a) basic life assurance and general annuity business (BLAGAB), which accounts for 80% of its business, and (b) pension business, which accounts for the remaining 20% of its business.  BLAGAB obtains a result of net income of £2m computed on the I minus E basis.  The pension business has a computed result (chargeable under Case VI) of £0.  The company has a fund which has foreign income of £200,000 of which  £160,000 (80%) is attributable to BLAGAB, and £40,000 (20%) to the pension business.  The £200,000 of foreign income has borne tax at a rate of 30% (i.e. £60,000).  The difference between the parties is that Mr Gammie contends for full relief for the foreign tax against the tax on the whole business; Mr Henderson contends for no relief for the foreign tax attributable to the pension business.
Contentions of the parties
33.	Mr Gammie starts from his contention on the first issue, which is the conclusion that we have reached, and contends:
(1)	The conclusion on the first is not affected by the fact that the computation of life assurance profit is made on the I minus E basis.  Subject to not reducing the profit below the Case I profit expenses of management are deductible against the profits of a life assurance company (s 76) (to be compared to the total profits of an investment company (s 75)), thus recognising that life assurance is a single source as provided by section 432:
“(1) Where an insurance company carries on life assurance business in conjunction with insurance business of any other class, the life assurance business shall, for the purposes of the Corporation Tax Acts, be treated as a separate business from any other class of business carried on by the company.”
(2)	The UK measure of foreign income is a receipt of that single business.  The credit is against the aggregate results of the insurance business and not against the separate pension business.  Section 436 treats the profits from pension business separately for the limited purpose of taxing those profits under Case VI:
“(1) Subject to the provisions of this section, profits arising to an insurance company from …pension business shall be treated as income within Schedule D, and be chargeable under Case VI of that Schedule, and for that purpose—
(a) [that business] shall be treated separately, and
(b) subject to paragraph (a) above, and to subsection (3) below, the profits therefrom shall be computed in accordance with the provisions applicable to Case I of Schedule D.
(2) Subsection (1) above shall not apply to an insurance company charged to corporation tax in accordance with the provisions applicable to Case I of Schedule D in respect of the profits of its ordinary life assurance business…”.
Subsection (2) shows that this rule is part of the I minus E basis.  For pension business the difference is that the “I” is computed on Case I principles.
(3)	In the above example the 20% of the foreign income apportioned to pension business is exempt from tax but this does not prevent credit being given for the whole of the foreign tax.  This is no different from the situation if there were a rule that the UK taxes 80% of a particular item of foreign income; credit for the whole of the foreign tax would still be given.
(4)	In the above example, the whole of the foreign income is creditable against the tax chargeable on the life assurance business as a whole.
34.	Mr Henderson contends that, following from his contention on the first issue:
(1)	Although life assurance business is a separate business it does not follow that foreign income is a receipt of that single business because of the need to identify the fund of UK income that corresponds with the item of foreign income.  The treaty provision can override s 436.
(2)	Because pension business is taxed under Case VI on the profit computed on Case I principles in a different way from other life assurance business, it has to be treated separately for double taxation relief purposes and credit is limited to the part of the corporation tax that is attributable to the foreign income.
(3)	In the above example, none of the tax on the foreign income attributable to the pension business is creditable because there is no Case I profit against which the part referable to the foreign income can be credited.
Reasons for our decision
35.	Essentially the difference between the parties is the time when the credit is taken.  Mr Gammie contends that it is taken first against the whole life assurance profits computed on the I minus E basis, while Mr Henderson contends that since pension business is taxed on a different basis it is necessary to identify the fund of UK income corresponding to the foreign income and treat pension business separately.  Double taxation relief is taken at the final stage of the computation, having calculated the UK tax on the profit.  The profit has to be computed first starting with a proportion of the income and using the different bases for the computation of the BLAGAB and pension business profit.  Because double taxation relief is calculated differently according to whether Case I principles or the I minus E basis applies because of the taxpayer’s ability to allocate expenses of management under s 797(3), whereas these are included with the E, it is necessary to compute the credit on the foreign income of the pension business separately because the profit is computed on Case I principles.  The fact that the Act does not apportion the foreign tax does not indicate that the credit is taken against the whole life assurance business profits, because the credit follows the computation of the profit.  In the light of our decision on the first issue we do not agree with Mr Henderson’s contention that the treaty overrides s 436  (which in any case would not apply to unilateral relief) but it is not necessary that the section be overridden to reach our conclusion.
36.	Presumably in cases other than the extreme one shown by the example, our decision on the first issue will mean that the part of the foreign income referable to the pension business will normally be credited against the tax on the profits of the pension business computed on Case I principles.
Issue 3
37.	As we have decided this issue following further information provided by the Revenue after the hearing we shall issue our decision on this issue in draft so as to enable the parties to comment on it before it is finalised.
38.	Accordingly this decision on issues 1 and 2 is an interim decision which we shall finalise later by including our decision on issue 3.  The time limits for appealing will not run until we have issued our final decision.
Conclusion
39.	In summary, our decision in principle on the first two issues is:
(1)	That in the circumstances of the example in paragraph 2 above the full amount of foreign tax is creditable against any corporation tax charged on the Case I profit in which the foreign income is a receipt, subject only to the limit of the maximum rate of credit in s 797.
(2)	Double taxation relief is computed separately for pension business in accordance with the Case I principles that we have decided in Issue 1.
40.	In accordance with section 56A(2) of the Taxes Management Act 1970 we hereby certify that our decision involves a point of law relating wholly or mainly to the construction of an enactment that has been fully argued before us and fully considered by us.  This means that if both parties consent, and if the leave of the Court of Appeal is obtained, either party may appeal from our decision directly to the Court of Appeal.

JOHN F. AVERY JONES

NUALA BRICE
SPECIAL COMMISSIONERS
RELEASE DATE: 28 January 2005

SC3043/04

Authorities referred to in skeletons and not referred to in the decision:
Kirkness v John Hudson & Co Ltd [1955] AC 696
Brook Bond & Co Ltd v Butler (1962) 40 TC 342
Johnson v Prudential (1998) 70 TC 445
Prudential v Bibby (1999) 73 TC 142
IRC v McGuckian [1977] 1 WLR 991
Manufacturers Life v Cummins (2000) 73 TC 306
Stevens v IRC  [2004] STC (SCD) 311
Barclays Mercantile Business Finance Ltd v Mawson [2004] UKHL 51